26 March 2018 Global Tax Alert France and Luxembourg sign a new double tax treaty EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: www.ey.com/taxalerts Executive summary On 20 March 2018, the new Luxembourg-France Income Tax Treaty (New Treaty) and a new protocol were signed by the Governments of France and Luxembourg, replacing the current double tax treaty signed on 1 April 1958 (Current Treaty). The New Treaty is based on the 2017 Organisation for Economic Co-operation and Development (OECD) Model Tax Convention (MTC), and contains significant changes including provisions to meet OECD standards, the definition of tax residency, and the withholding tax treatment of dividend distributions. The New Treaty is likely to significantly impact tax structuring of French real estate investments via Luxembourg but will also require the review of certain existing or prospective structures with respect to the broader risk of recognition of a permanent establishment. Given the terms of Article 30 of the New Treaty relating to its entry into force, the new provisions could be effective as from 1 January 2019. This Alert summarizes the key changes and new provisions under the New Treaty based on the latest draft available at the date of the issuance of this Alert.
2 Global Tax Alert Detailed discussion Overview In accordance with the new international standards outlined in the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI), the preamble text of the New Treaty addresses its objective, which is to definitely exclude any forms of tax avoidance and evasion. For example, the wording used in the New Treaty is exactly the same as the one used in Article 6 (1) of the MLI and in the 2017 OECD MTC. Tax residency Article 4 In line with the above, the New Treaty follows also the 2017 OECD MTC on the definition of the term of residency. However, some specificities are provided, including: A trustee or fiduciary is not considered a resident of a Contracting State even if covered by the definition of a resident, provided that it is only the apparent beneficiary of the income, while such income benefits in fact, directly or indirectly through the intermediary of other individual persons or companies, another person which does not qualify itself as a resident within the meaning of Article 4 of the New Treaty. In the case of France, residents also include partnerships (société de personnes), groups (groupement de personnes) or similar entities meeting the following criteria: Place of effective management is situated in France They are subject to tax in France Unitholders, partners or members are, pursuant to French tax law, personally liable to tax on their portion of profits of these partnerships, groups or similar entities Within the meaning of Article 4, French Sociétés Civiles Immobilières (SCIs) should therefore fall within the scope of the definition of resident from a French perspective. Permanent establishment Article 5 Under the New Treaty, the concept of Permanent establishment (PE) is now also in line with the 2017 OECD MTC. Further to the amendments, the period required to qualify a building site or construction or installation project as a PE is extended to 12 months (instead of the 6 months in the Current Treaty), although the method of computation of the 12 months is broader than before. In addition, the definition of a PE under the New Treaty aims at structuring used to prevent the recognition of a PE through agency or commissionaire arrangements (Article 5 (5) of the New Treaty), or the exception applicable to activities of a preparatory and auxiliary character (Article 5 (4.1) of the New Treaty). This results in a broader risk of recognition of a PE in a Contracting State, under certain circumstances. As a consequence, the business model of certain banks, insurance companies and fund management structures may need to be carefully monitored, taking into consideration these changes. Dividends Article 10 The provisions of Article 10 of the New Treaty have been amended in order to reflect an exemption from withholding tax on the gross amount of the dividends if the beneficial owner is a company which holds directly at least 5% of the capital of the company paying the dividends (instead of 25% under the Current Treaty) during at least a 365-day period that includes the day of the payment of the dividend. Article 10 (6) of the New Treaty also introduces a specific rule for allocation of taxing rights over real-estate linked income distributed by certain types of investment vehicles, namely vehicles that: (i) distribute the majority of their profits annually; and (ii) benefit from an exemption on their real estate income. Henceforth, under the New Treaty, dividends distributed by some investment vehicles remain subject to tax in the country of their residence. Such tax will be withheld at domestic tax rates (i.e., 15% in Luxembourg and 30% in France at the date of this publication), unless the beneficiary of the income holds less than 10% of the capital of the distributing investment vehicle, in which case a reduced 15% withholding tax should be applicable. As expected, investment vehicles such as SPPICAV (Sociétés de Placement à Prépondérance Immobilière à Capital Variable) and SIIC (Sociétés d Investissement Immobilier Cotées) are targeted by this provision, which in practice leads to the application of French withholding tax of 30% on their future distributions in most of the existing SPPICAV and SIIC structures. Moreover, such dividends received by a Luxembourg company will no longer benefit from a treaty exemption as provided for by the Current Treaty and should therefore be taxable in Luxembourg as the participation exemption, as transposed in Luxembourg, does not normally apply to SPPICAV or SIIC.
Global Tax Alert 3 As a consequence, the Luxembourg-French SPPICAV holding structures are likely to be affected by New Treaty and become more stringent, although the potential 30% withholding tax withheld by France could, under certain conditions, give rise in Luxembourg to a tax credit at the level of the Luxembourg company (Article 22 (2) b of the New Treaty). Capital gains Article 13 In line with the Current Treaty, Article 13 (1) of the New Treaty provides that capital gains realized by a resident of a Contracting State from the alienation of immovable property situated in the other country are to be taxed in that other country. The New Treaty introduces an extended provision for the alienation of shares of companies deriving more than 50% of their value directly or indirectly from immovable property. Indeed, the wording of Article 13 (4) of the New Treaty adds an additional layer of complexity to this so called real estate rich company provision. The situation at the time of the alienation of shares of a real-estate-rich company would no longer be relevant to the allocation of taxing rights. Indeed, if at any time during the 365-day period preceding the sale of such shares, the company being sold derived more than 50% of its value (directly or indirectly) from immovable property, the taxing right would be allocated to the country where real estate is located. Thus, the composition of assets and their value will need to be monitored on a daily basis adding a new administrative burden to the management of real estate structures. Moreover, it is important to note that this provision adds indirectly a retroactive effect to the entry into force of the New Treaty for real estate structures, as for any sale occurring after the New Treaty becomes effective, the value of the shares will need to be traced back 12 months. The extension of the scope of the real estate rich clause is consistent with the provisions of the MLI. It should however be noted that Luxembourg had a reservation against this proposed amendment when signing the MLI. Anti-abuse provision Article 28 As expected, the New Treaty also includes an anti-abuse provision based on the Article 20 OECD MTC similar to the principal purpose test opted by the Luxembourg under the MLI. Notwithstanding the other provisions, a benefit under the New Treaty shall not be granted in respect of an item of income or capital if it is reasonable to conclude, taking into account all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the objective and purpose of the relevant provisions of the New Treaty. Entry into force Article 30 The New Treaty is expected to enter into force as from 1 January 2019 but only after completion of the procedures required by the domestic law of Luxembourg and France. Notwithstanding the entry into force of the New Treaty, the Current Treaty should remain applicable. Implications The provisions of this New Treaty are expected to have a significant impact on major business sectors such as real estate and the banking industry as well as to a certain extent, the insurance and fund management industry. Particular attention should be paid to real estate structures which may be subject to significant taxes at the level of the withholding tax to be applied on dividends distributed by a French SPPICAV or SIIC to its Luxembourg shareholder.
4 Global Tax Alert For additional information with respect to this Alert, please contact the following: Ernst & Young Tax Advisory Services Sarl, Luxembourg Marc Schmitz marc.schmitz@lu.ey.com Dietmar Klos dietmar.klos@lu.ey.com John Hames john.hames@lu.ey.com Alain Pirard alain.pirard@lu.ey.com Ernst & Young Société d Avocats, Paris Eric Verron eric.verron@ey-avocats.com Philippe Legentil philippe.legentil@ey-avocats.com Xavier Dange xavier.dange@ey-avocats.com Ernst & Young LLP, Luxembourg Tax Desk, New York/Chicago Serge Huysmans serge.huysmans@ey.com Alexandre J. Pouchard alexandre.pouchard@ey.com Ernst & Young LLP, French Tax Desk, New York Frédéric Vallat frederic.vallat@ey.com Mathieu Pinon mathieu.pinon1@ey.com Abdallah Ziouche abdallah.ziouche@ey.com Ernst & Young LLP, Financial Services Desk, New York Jurjan Wouda Kuipers jurjan.woudakuipers@ey.com Sarah Belin-Zerbib sarah.belinzerbib@ey.com
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